The Housing Crisis: Who Is To Blame?

REAE 5311, Spring 2009 Blog

Hundreds to thousands of foreclosure signs have gone up in front of homes every week in the United States for the past several months; it’s amazing to think just a few years ago houses were being built and sold in this country at an alarming rate. Before a builder could even complete the foundation of a new home in some areas of the country like Arizona and Florida, eager owners were bidding on them. Now these once occupied dwellings are being put on auction blocks at the same fast rate they were being constructed and purchased, perhaps even faster. How could such a dramatic change of events occur in such a short time span? How could the American dream of owning a home become such a nightmare for millions of families? With billions of taxpayers’ money being spent to repair the damaged housing market, everyone is left searching for answers too so many questions. One question that will probably never be answered though is “Who is to blame?” The finger pointing began long before the problem reached its boiling point and yet no solitary cause has been identified, but many theories exist. Perhaps the fault belongs to the lenders and banks for loaning money to anyone who walked through their doors with their hands out. Maybe it’s the blunder of home builders for taking advantage of what seemed like a golden opportunity in their industry that would never come to an end, by building a new home in every nook and cranny of the country. Typically we blame the government for most of our country’s problems and maybe this is no exception. Obviously regulators fell asleep at the wheel and neglected the warning signs of what could happen. Considering it wasn’t too long ago we faced another bubble burst known as Dot Com, preventive measures could and should have been taken too avoid going down this path again. “We should have recognized a bubble when we saw it; just a few years before, another market bubble collapsed—in technology stocks and all the signs were there in housing,” (Bogoslaw & Steverman). Fannie Mae and Freddie Mac are also easy targets; these government sponsored enterprises (GSE’s) were created during the Great Depression to securitize mortgages for lending financial entities. With so many banks going under of late because of the bad mortgages sitting on their books, I don’t think the GSE’s deserve a pat on the back for doing such a good job themselves. Perhaps though the responsible party for this mess is the hundreds of thousands of homeowners who couldn’t afford to rent a home, let alone buy one. Oh where to begin……

Let’s start with the government and its two once privatized, but now conservatory companies Fannie Mae and Freddie Mac. Until this past year, most citizens had never heard of these firms, but essentially they have a hand in almost every mortgage transaction that takes place in the U.S. oth corporations as mentioned earlier, were created by the federal government to purchase and securitize mortgages, ensuring funds would be available to financial institutions that provided loans to the home buyers. Basically, they were a safety net for banks should a borrower default on their loan. When these mortgages are bought by Fannie and Freddie, they are then combined into packages and sold to investors in the open market as mortgage-backed securities. Every mortgage lending institution does work with the two firms and “by 2008 investors around the world owned $5.2 trillion of debt securities backed by these companies. In fact, Fannie and Freddie themselves owned or guaranteed about half of the U.S.’s $12 trillion mortgage market, “(Duhgg). With so much money indebted in one industry, it’s no surprise investors and the government became concerned in the summer of 2008 when both companies stated they were facing financial troubles. Unfortunately however, the problems began a year earlier when the subprime mortgage crisis began and the root cause of the mortgage, financial, and economic crisis now plaguing the world, started to evolve. Where was the government to stop this madness? Many argue more regulation and intervention was necessary to control the trading of these financial assets and the lending practices being used to prevent the problem from becoming as large as it has. Others argue too much regulation employed by local and state governments was part of the problem, in that they caused home prices to rise to unsustainable levels. An example of this over-regulation occurred in the 1960s and 1970s when California and Hawaii employed Growth Management Planning to control and limit where home building took place. “These states effectively drew a line around a city, and allowed building inside the line, but not outside; over time, such regulation has spread dramatically,” (Hassett). With such constraints being placed on land usage and demand for new homes continuing to rise, the low supply level forced prices higher. This is where home builders become a factor.

Money is typically associated with the word inflation, referencing an increase in the money supply, but it can also means a rise in the price of goods and services, including real estate. In the years during the housing boom homes could not be built fast enough to keep up with the increasing demand of those who wanted to purchase them. This rise encouraged builders to raise their supply level, but the affect on prices by doing so can vary. Prices can increase, decrease, or not shift at all and remain at their current positions. For the housing market though, the equilibrium price rose and continued to rise as more and more future homeowners entered the market. So why would builders continue to put up new houses? Simple, to make more money because the more homes that were built and available on the market to sell, the more profits builders were able to attain. This favored Wall Street as well because the more houses that were bought and sold, the more mortgages Fannie and Freddie were able to purchase, package, and sell to investors who were eager to have them to sell around the world, yielding a profit for themselves. “It was music to the ears of Wall Street bankers whose business was to pool mortgages and sell them to investors who would then get the monthly payments those mortgages produced. The more mortgages lenders provided to homebuyers, the more product available to sell,” (Jacoby & Landers). In an effort to continue this revenue cycle much like what car dealerships do when they have a prospective buyer on their lot, builders strongly encouraged homeowners to finance through them, “an arrangement of the sort that helped fuel the long housing boom across the country,” (Hovanesian). It seemed at the time nothing could slow the money train down, but how quickly people forget. Like gravity, what goes up must come down and just like the event known as the Dot Com Bubble that not too long ago rattled our economy, we were about to face the same problem. If people didn’t believe in the phrase “history repeats itself” beforehand, they should now. Irrational and irresponsible behavior on the part of builders inflating the demand and prices of homes to unsustainable levels has helped burst another bubble and sent the housing market crumbling; still more blame can be passed around.

With all of the bailout money being given to so many financial institutions, many are now realizing how imperative these organizations are to our economic well-being. They flush money into our economy much like the heart pumps blood into the body. In fact, many economists and financial analysts have referred to banks as the “circulatory system” of our country. So why would an industry that plays such a crucial role in the health of our economy make so many mistakes and quite honestly, deceitful acts jeopardizing our well-being? Once again the answer is easy, to make money. Prior to 2000, the process to getting a home mortgage loan took forever with seemingly endless amounts of paper work. Personally I would not be surprised if many potential homebuyers were scarred away from buying a home because of the tedious process involved. Unfortunately, more people than ever wanted to buy at that time, but not all of these individuals qualified for a loan under the normal standards used by lenders. Banks then had to be creative in finding ways to get these prospective buyers into houses. Enter the subprime mortgages, no-document (no-doc.) loans, adjustable rate mortgages, and many more. Despite having different names, all of these loans have one thing in common, they were created and used to allow families to purchase homes they really could not afford. You have probably heard more than your fare share about how these mortgages work, so I won’t go into detail on what they all mean and how they operate. The thing you need to know is they are inappropriate means of lending money because they all break the rules of the normal home buying process. Being approved for a home despite having a poor credit rating or not providing documentation to prove your income or paying nothing in down payment are all against the traditional lending practices. With the introduction of these new methods of lending, a false impression was given to borrowers that these institutions were helping them. Now we have come to find out they have hurt them and are a major reason why so many foreclosures have occurred. No one would believe that managers, executives, and other officials at these banks did not know what they were doing and how risky their actions were. So it should be no surprise why so many Americans are furious at the idea of using taxpayer funds to keep these same banks from going out of business. Despite the irresponsible decisions made by so many individuals in these industries and the lack of oversight from the government, there’s still one group who deserves a good amount of blame, perhaps more than anyone else, the home owners.

Let’s face it, the lying and cheating was not just done by the investors on Wall Street or employees at the banks, those of us on “Main Street” bear some responsibility as well. Now personally, I place more blame on the groups of individuals I have previously discussed, those who are highly educated in the areas of finance and real estate. These are the people we expect to operate at higher standards and more hold more accountability for their actions because of the extensive knowledge they possess in these respective markets. With that being said however, the home owners now struggling to make their monthly payments and facing foreclosure did not have to do some of the things they did to purchase the home. Since when is lying about your income to buy something you know you can’t afford a good idea? The combination of low income and no assets equals disaster. It doesn’t end there for homeowners though, greed played a role in the decisions they made after they moved into their homes. Refinancing became an addiction because home prices were so high. Money was then used to shop, driving retail sales through the roof and further providing the false impression our economy was strong. Granted not every struggling homeowner falls into the category of being an irrational buyer who took on more debt than they could afford. There are those individuals who purchased homes they could afford using the standard mortgage loan procedures and those are the ones who should receive government/taxpayer assistance. But for those who can’t keep up with their monthly bills and already have a sizeable amount of debt they are struggling to pay down, purchasing a house should be the last item on your wish list, something many who are in foreclosure now are realizing. There’s nothing wrong with renting, I happen to think it has more advantages then owning a home. During the real estate boom though, people bought homes as if renting an apartment was something to be ashamed of and now they are where they probably should have been all along, renting.

Everyone in the categories I have mentioned thus far made mistakes that could have been avoided to prevent this from happening. There are however, many other groups of individuals I didn’t even discuss whose actions enhanced the problem as well. Let’s not forget about Loan Officers who made more money by approving more loans whether the borrowers could really afford them or not, credit rating agencies who rated mortgage backed securities at levels higher than they should have, inexperienced bankers who did not have the necessary education and training to perform their job, and many others. Accountability comes with mistakes and while ultimately for the good of our economy, we cannot allow this trend of foreclosures to continue, how will anyone learn from their mistakes if they don’t suffer the consequences of their actions? What’s most important though is for us to take the necessary steps to prevent this from happening again, by living within our means and the government doing more to regulate the actions of businesses involved in the real estate industry. Greed has such a profound affect on the decisions we make and the actions we take, as evidenced by what I have disucssed. The long term effects of those decisions and actions however, have consequences people don’t discover until it’s too late. We can no longer base our behavior solely on money; we must act more responsibly for the sake of ourselves, family, and communities. More importantly though, we all must use better judgment when making choices in our lives. We can’t rely on others to always do what is right, but we should always hold ourselves to higher standards and levels of accountability in the future to prevent another economic disaster such as this because I’m sure no one wants to encounter this again.

References:

Bogoslaw, David & Steverman, Ben. The Financial Crisis Blame Game. Business Week. October 2008.

Duhgg, Charles. Loan-Agency Woes Swell From a Trickle to a Torrent. The New York Times. July 2008.

Hassett, Kevin. Regulations Are At The Root Of U.S. Housing Mess. Bloomberg.com. March 2008.

Hovanesian, Mara Der. Bonfire OF The Builders: By rushing Into The Mortgage Business Big-Time, Homebuilders Helped Fuel The Housing Crisis. Business Week. August 2007.

Hovanesian, Mara Der. Builder Role In The Housing Crisis. Business Week. September 2007.

Jacoby, James & Landers, Jill. CNBC Special Report: House of Cards. Consumer News and Business Channel. February 2009.